What will be the future price on carbon?

We know the starting price for carbon will be $23 but once trading in carbon permits commences in 2015, we enter the murky area of international politics and carbon markets.

Based on the legislation before us we know that the carbon tax will begin from Sunday at $23 per tonne of CO2 emitted. This will then increase in real terms by 2.5% for 2013-14 and again in 2014-15.

After this the intention is that the carbon price will be set by market trading in Australian permits, as well as the use of international carbon credits, known as Certified Emission Reduction units, that are managed through a United Nations’ process called the Clean Development Mechanism. Certified Emission Reduction credits or CERs, can be created by a range of activities in developing countries such as generating electricity from wind farms, capturing the methane (a gas with a warming effect more than 20 times as powerful as carbon dioxide) from landfills and using it to generate electricity, and replacing inefficient light-bulbs with more efficient compact fluorescent globes.

While the Australian Government will not recognise all types of CERs, for the most part these credits can be used as a one for one replacement with Australian permits. Therefore the price of Australian permits has the potential to be heavily tied to the price of CERs just as occurs under the New Zealand emissions trading scheme.

CERs are currently trading at around $5. Based on the current large supply of CERs, and the heavily depressed demand for them from their main market – the European Emissions Trading Scheme – carbon market analysts expect the price for them to remain quite low out to 2020 at close to $5 per credit. Because the supply of CERs is so large and they are recognised by the government as an equivalent replacement for Australian permits, Australia’s carbon price would be expected to descend to this $5 price once trading commences, were it not for the government-mandated floor price.

This floor or minimum price for carbon has been set by the government at $15 in 2015-16, and will rise by 4% per annum in real terms (inflation adjusted) for the next 2 years. The government has not specified that the floor price would continue after this time. Most analysts expect that once trading commences the carbon price will be set by the floor.      

The one complication to these price outlooks is that government policy could change – in both Australia and overseas that could dramatically change this price outlook.

Europe is seriously considering a range of proposals to reflate the price of carbon under their emissions trading scheme. These include with-holding more than a billion permits from the market, increasing the stringency of their emissions reduction target and implementing their own floor price. Some of these measures could also act to increase the price of CERs.

Also other countries and jurisdictions have emissions trading schemes under development who may emerge as buyers of CERs in the future. Also some presently large sources of CERs could be deemed ineligible in the future, leading to a large withdrawal of supply. As an example the Chinese government has been heavily promoting wind power and there are questions about whether there is a need to provide CER-based funding to enable these projects to occur.

Lastly the Australian Government could decide that it is uncomfortable with achieving its abatement targets through a very heavy reliance on overseas abatement credits. This could come down partly to political reasons – voters may be unhappy with a scheme that involves them funding countries overseas to decarbonise their economies, even if this increases costs of achieving abatement targets. In addition it may be driven by national interest concerns because there is no international agreement in place beyond 2012 that ensures these CERs will count for something under any future international agreement. 

Carbon tax special report – everything you need to know for July 1...